If you go to your local banker and ask or search online for “How much house can I afford?” you’ll get an answer that will likely prevent you from ever retiring. Why? Because lenders are answering the question, “How much house can I afford?” and not “How much house can I afford and still retire?” These are different questions, and it’s important to understand the difference. Those who do, can likely retire. Those who don’t, probably can’t.

Photograph by Ellen Jaskol

Charlie Farrell

This question is more important today than a few years ago, as real estate prices in many areas of the country (including Denver) are steadily increasing. Here’s the problem: Lenders don’t think about how much you need to save for retirement. They look at your income and immediate expenses. Thus, in their lending formulas, money that should go to retirement savings goes to cover a higher mortgage payment.

The typical mortgage formula allows you to borrow 3.5 to 4 times your annual income to buy a house. At that level, you’ll likely spend 30 percent to 35 percent of your gross income on your mortgage payment. Add another 20 percent to 25 percent for taxes, and half your income goes to creditors (the bank and Uncle Sam). Then you’ve got other things to pay for, like food, clothing, education costs, child care, health care, and the list goes on. At the end of the month, it’s unlikely you’ll have much money to put into a 401(k) plan.

If you want to save to help ensure a secure retirement, you need to sock away about 12 to 15 percent of your pay every year. Most people can’t do this because their mortgage consumes about 12 to 15 percent more of their monthly income than it should.

When you’re considering a mortgage, try committing no more than 20 percent of your monthly income to your payment. That likely means you’re borrowing closer to 2.5 times your salary.

Here’s a simple example: If you earn $100,000 a year and have a $250,000 mortgage, your monthly payment on a 30-year mortgage will be about $1,200 a month at an interest rate of about 4 percent. Add in funds for real estate taxes and insurance, and you’re likely going to pay more than $1,500 a month, or about 18 to 20 percent of your gross income.

Another 20 to 25 percent of your money will go to taxes (federal and state income taxes and FICA taxes). If you contribute 15 percent of your salary to savings, you have about 40 to 45 percent of your income left to live on. You’ll find this is a lot more comfortable and in many cases achievable. Moreover, if you put your retirement savings in your 401(k), you’ll get an income tax deduction for the contribution. This basically makes it easier to save and has less impact on your take-home pay.

To simply your calculations, consider borrowing no more than 2.5 times your household income. This should leave adequate room to save for retirement. Budgeting might seem intimidating, but spending time to understand the basics of your own income and spending capacity will pay dividends down the road. If you’re confused about your budget, an accountant or a certified financial planner can help. These decisions are too important to leave to guesswork.

A main problems with defining the American dream as home ownership is it can lead people to spend too much on a home. Define your American dream as home ownership and retirement. If you want to do both, then you need to follow a formula that allows for both.

What happens if you live in an area where you can’t buy a home under these parameters? Well, you could move to a more affordable area. Much of the Midwest and the South is more affordable than the rest of the country. You could also move to a more rural area, but often that creates employment challenges.

Another option is to retire in an area that is less expensive. You can buy a less expensive house and take your excess home equity and put it toward your retirement portfolio. If you’re considering this strategy, do so with your eyes wide open about the lifestyle changes you’ll need to make at retirement and the risk involved in betting on real estate, and be sure your significant other is on board with it.

Charlie Farrell is a CEO of Northstar Investment Advisors LLC, and guides the firm’s investment philosophy. He is the author of “Your Money Ratios: 8 Simple Tools for Financial Security.” This article is for information and education purposes only. It does not constitute investment, tax or legal advice.

More in Business

A prominent white nationalist is suing Twitter for banning his accounts at a time when social networks are trying to crack down on hateful and abusive content without appearing to censor unpopular opinions.

The social media service Twitter is believed to have suspended thousands of accounts for being automated bots, or for other policy violations, drawing outcry from fringe conservative media figures who lost followers in the move.

Two senior U.S. Geological Survey officials have stepped down after Interior Secretary Ryan Zinke demanded that they provide his office with confidential data on the National Petroleum Reserve-Alaska before it was released to the general public.